No Comment
FINRA Annual Regulatory and Examination Priorities Letter

On February 8, 2011, FINRA published its 2011 Annual Regulatory and Examination Priorities Letter to member broker-dealer firms to highlight new and existing areas of significance to their regulatory programs. The following provides a summary of the letter, including an overview of the recent regulatory developments and an outline of the examination priorities for member firms.

I.  Recent Developments

Suitability – FINRA Rule 2111: requires a broker to have reasonable basis to believe that a recommended transaction or investment strategy involving or securities is suitable (see Regulatory Notice 11-02)

Know Your Customer – FINRA Rule 2090: requires a firm use “reasonable diligence” in regard to the opening and maintenance of every account, to know the “essential facts” concerning every customer (see Regulatory Notice 11-02)

Financial Responsibility – FINRA Rules 3110, 4120, 4140, 4521, 9557 and 9559 – enable FINRA to prescribe greater net capital requirements for carrying and clearing member firms in certain circumstances (see Regulatory Notice 10-21)

Reporting Requirements – FINRA Rule 4530 – requires member firms to report certain events (see Regulatory Notice 11-06)

II.  Examination Priorities

Fraud Detection

  • Spot and investigate red flags that may indicated fraudulent behavior
  • Rule 4160 – strengthens FINRA’s ability to verify independently customer and proprietary assets maintained by member firm at a non-member financial institution

Fraudulent Activity Associated with Customer Accounts

  • Maintain robust supervisory systems and AML monitory systems that are reasonably designed to detect and report suspicious transactions

High-Frequency Trading, Algorithms, Sponsored Access, Direct Market Access and Trading Pauses

  • Establish effective controls over electronic order routing and market access arrangements, including surveillance of algorithmic trading and HFT strategies (see Securities Exchange Act Rule 15c3-5 and NTM 04-66)

Short Sales and Regulation SHO

  • Regulation SHO amendments – implement a short-sale related circuit breaker for NMS stocks

Information Barriers

  • Concern over weak information barrier controls around the flow of material, non-public information within the firm and with its affiliates, clients and others

Private Placements and Private Self-Offerings

  • Focus on the retail sales of private placement interests due to failures identified in firms’ compliance with suitability, supervision and advertising rules as well as potential fraud and participation in illegal distribution of unregistered securities
  • Regulatory Notice 10-22 – obligation to conduct reasonable investigations into Regulation D offerings
  • Regulatory Notice 11-04 – proposed expansion of Rule 5122 to cover all private placements in which broker-dealers participate

Trading in Non-Public Securities

  • Following trends in unregistered shares of companies that report no public information

High-Yield Investments

  • Concern over retail investors attracted to high yield may not understand risks associated with credit risk and liquidity – reasonable-basis and customer-specific suitability analysis

Municipal Securities

  • Must meet disclosure, suitability and pricing obligations and obligation to deal fairly with customers

Non-Conventional Investments

  • Focus on firms that offer structured products and certain riskier asset-backed securities – brokers must understand the risks and costs associated with the products they recommend and disclose them to customers
  • Non-traded REITS – risk of attracting investors who do not understand the extent of risks, including lack of liquidity, lack of accurate and up-to-date valuations, impact of fees, potential conflicts between their interests and those of REIT managers and dividends that may represent a return of capital rather than operating income
    • Recent events of concern: share devaluations, dividend cuts and suspension of share buyback programs
    • Examiners will review sales to unsophisticated investors to ensure firms conducted appropriate pricing due diligence and suitability analyses and disclosed all risks

Exchange-Traded Funds and Notes

  • See Regulatory Notices 09-31 and 10-51

Vulnerable Customers

  • Firms must be sensitive so that brokers do not place vulnerable customers (retired, elderly or ill) into inappropriately risky products

Electronic Communications and Social Media

  • Firms must establish an adequate system to retain and supervise all electronic business communications
  • Any electronic communications sent to a customer or prospective customer regardless of medium or origination is subject to FINRA and SEC rules regarding communication with the public, including supervision and retention
  • See FINRA’s Guide to the Internet for Registered Representatives and Regulatory Notices 07-59 and 10-06

Consolidated Account Reports

  • Firms must have procedures in place to conduct due diligence on the valuation of such wide variety of asset classes prior to inclusion on financial account reports to customers
  • Regulatory Notice 10-19 – guidance and reviews rules on consolidated financial account statements, including when assets are not in the broker-dealer’s possession or control

Hiring and Compensation Practice

  • Attention to supervision of newly hired individuals and enhanced compensation practices

Outside Business Activities and Private Securities Transactions

  • FINRA Rule 3270 – prohibits registered persons from engaging in OBA unless prior written notice, provides firm’s obligations and recordkeeping requirements
  • Firms must understand the nature and extent of approved private securities transaction, document the process for review, and effectively supervise any approved transactions
  • Examinations will continue to focus on notification and approval requirements, but also substantive reviews of the activities (see Regulatory Notice 10-49)

Master/Sub-Account Relationships

  • FINRA will review firms’ systems for monitoring, detecting and reporting suspicious activity in such structures, whether or not the sub-account should be considered the firm’s customer for CIP purposes (see Regulatory Notice 10-18)

Funding and Liquidity Risk Management

  • Firms must be prepared to manage their daily operations under severe and prolonged adverse market conditions – independent risk oversight by senior management

Intercompany Transactions/Affiliate Relationships and Activities

  • Accurate books and records for affiliate transactions – see NTM 03-63

Governance and Control over Margin Lending

  • Governance process designed to control risks around margin lending, including assessing the type and sufficiency of collateral, credit worthiness of the borrower, valuation and liquidity of the collateral, concentrations of collateral, ability to fund the loan and other factors.

Please contact our firm if you need assistance modifying your written supervisory procedures, provide a compliance assessment, assist with any regulatory examination, or any other regulatory or arbitration related legal advice at

Link: Broker-Dealer Advisory Services

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No Comment
FINRA Arbitration Panel Composition – Regulatory Notice 11-05

On February 1, 2011, FINRA amended the Code of Arbitration Procedure for Customer Disputes to allow customers with claims in excess of $100,000 to have two options for panel composition, either: (i) majority-public panel with two public and one non-public arbitrator or (ii) optional all public panel with all public arbitrators.  For further information, including full text of the notice and the amended and consolidated rules associated, please see FINRA’s website.

The California-based law firm of Evans & Kob PC represents representatives, firms and supervisors before all regulatory agencies, including FINRA arbitration. Please contact our law firm at to discuss with one of our lawyers about representation and our arbitration and litigation practice. Expertise and experience matter and help to provide the best possible outcome.

Link: Arbitration and Litigation

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No Comment
Know-Your-Customer and Suitability Obligations

SEC approves consolidated FINRA rules governing Know Your Customer (Rule 2090) and Suitability Obligations (Rule 2111), effective October 7, 2011.

Know Your Customer

In general, new FINRA Rule 2090 (Know Your Customer) is modeled after former NYSE Rule 405(1) and requires firms to use “reasonable diligence,” in regard to the opening and maintenance of every account, to know the “essential facts” concerning every customer.6The rule explains that “essential facts” are “those required to (a) effectively service the customer’s account, (b) act in accordance with any special handling instructions for the account, (c) understand the authority of each person acting on behalf of the customer, and (d) comply with applicable laws, regulations, and rules.” The know-your-customer obligation arises at the beginning of the customer-broker relationship and does not depend on whether the broker has made a recommendation. Unlike former NYSE Rule 405, the new rule does not specifically address orders, supervision or account opening—areas that are explicitly covered by other rules.


New FINRA Rule 2111 generally is modeled after former NASD Rule 2310 (Suitability) and requires that a firm or associated person “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile.” The rule further explains that a “customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.” The new rule continues to use a broker’s “recommendation” as the triggering event for application of the rule and continues to apply a flexible “facts and circumstances” approach to determining what communications constitute such a recommendation. The new rule also applies to recommended investment strategies, clarifies the types of information that brokers must attempt to obtain and analyze, and discusses the three main suitability obligations. Finally, the new rule modifies the institutional-investor exemption in a number of important ways.

Additional Topics

FINRA Regulatory Notice 11-02, which discusses the consolidated rules continues on to discuss the determination of the existence of a recommendation, explicitly state the application to investment strategies involving securities, inclusion of an expanded list of explicit types of information to gather and analyze as part of the suitability analysis (adding age, investment experience, time horizon, liquidity needs and risk tolerance to the existing list of other holdings, financial situation and needs, tax status and investment objectives, lists three main suitability obligations: reasonable-basis, customer-specific and quantitative suitability and provides an exemption to customer-specific suitability for recommendations to institutional customers under certain circumstances.

Please contact our firm if you need assistance modifying your written supervisory procedures, new client forms or other securities, regulatory or arbitration related legal advice at

Link: Broker-Dealer Advisory Services

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No Comment
Proposed Amendments to FINRA Rule 5122 Addressing Private Placements – Regulatory Notice 11-04

FINRA issued a proposed amendment to Rule 5122 requiring disclosure in the offering document of the intended use of offering proceeds, expenses, and the amount of selling compensation to be paid to he broker-dealer and its associated persons, in any private placement in which a participating broker-dealer (or its control entity) is the issuer. In addition, the rule requires: at least 85 percent of the offering proceeds must be used for the business purposes identified in the offering document and each offering document to be submitted to FINRA to allow the staff to conduct ex post reviews to assess compliance with the rule and to identify problematic terms and conditions.

Further, the proposed amendments expand Rule 5122 to reach all private placements in which a member firm participates—not just those in which the member firm (or its control entity) is the issuer—while retaining nearly all of the existing exemptions, including those for offerings sold solely to certain institutions, qualified purchasers and other sophisticated investors. However, to reflect the broader scope of the proposed rule and its prior experience with Rule 5122, FINRA proposes to eliminate the exemption for offerings in which a member acts primarily in a wholesaling capacity.

Comment Period Expires: March 14, 2011

To see the full text of Notice 11-04 and proposed amendments, please follow this link to FINRA’s website.

Please contact California-based Evans & Kob PC regarding any of your securities or regulatory questions at

Link: Broker-Dealer Advisory Services and Securities Offerings practice areas.

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